Increased risks of directors’ liability due to COVID-19
The outbreak of the coronavirus has had an impact on the entire economic system, causing many companies to suddenly end up in severe weather that leads to their financial situation has being carious. Research by the expert agency Graydon indicates that one in four Belgian companies will not be able to cope with the shock of the current corona crisis if no income is generated for two months. The directors should be extra attentive in this respect, as their liability can quickly be jeopardized if they do not respond in time or if they still enter into commitments that the company can no longer bear in the current circumstances.
We will hereinafter indicate the main risks of liability in the event of a bankruptcy, so that you know how to react as a prudent director.
Stop loss procedure
When your company ends up in a difficult financial situation, the directors must respond in a timely manner. Article 2:52 of the Belgian Code of companies and associations (“BCCA”) even expressly provides that when compelling and corresponding facts may jeopardize the continuity of the company, the directors must deliberate on the measures to be taken to ensure continuity of the economic activities for a period of at least twelve months. De facto, this will force many companies to take immediate action if they are greatly affected by the current COVID crisis. We recommend also recording in writing the discussions within the board of directors in order to demonstrate in a worst-case scenario that action was been taken in due time.
If the financial situation becomes critical, the directors must start the so-called “stop loss” procedure. To this end they have to convene a general meeting of shareholders within two months after they took notice of the situation. The latter must decide on the dissolution of the company or on the measures announced in the agenda guarantying continuity. The board must explain its proposals in a special report. This stop loss procedure must within a private limited liability company (i.e. BV/SRL being formerly BVBA/SPRL) must be initiated if net the assets have become or are likely to become negative. In the case of a public limited liability company (i.e. NV/SA), the procedure applies when the loss suffered (i) has reduced the net assets to less than half of the share capital or (ii) to less than a quarter of the share capital.
Liability in the event of bankruptcy
Where the directors make their decisions in principle with a view to the further development and profitability of the company, their role can suddenly change when its continuity is threatened. After all, in the event of bankruptcy, the liquidator will scrutinize the decisions and conduct of the directors and, if necessary, invoke their liability. They can indeed be held liable on various grounds, not only by the liquidator, but in some cases also by other interested parties (i.e. creditors, employees, government, shareholders, etc.):
- Ordinary ground of liability
All regular liability grounds of a director can also be invoked after the bankruptcy of a company.
In many cases, claims are even only initiated after a bankruptcy, since the actions of the directors are only then examined. For example, violations of the articles of association or the BCCA often lead to liability, although a causal relationship between the error and the damage is to be demonstrated. In some cases, the law does provide for a presumption of causality, as a result of which liability is jeopardized much more quickly.
- Liability for failure to report bankruptcy on time
In accordance with article XX.102 of the Belgian Code of Economic Law, a company must file for bankruptcy within one month after it suspended its payments. If this is not done in time, the directors’ liability may be jeopardized. After all, they must monitor the financial situation of the company and are the body authorized to file such declaration. Failure to report in time does not automatically lead to liability, but you will have to act carefully and always motivate why the filing has not yet been done. The reasons for this may be, for example, a contract that will be signed shortly, savings measures that have been taken, etc.
- Liability for continuing a deficit company
By continuing a loss making company without any realistic prospects for the future, increases the liability of the directors. Directors who perpetuate the activities, enter into new contracts, engage in new commitments, etc., knowing that the company can no longer be saved, can be addressed by the company itself as well as by third parties for aggravating the debt position.
- Liability for entering into certain commitments
Directors can be held liable for actions that have damaged the collateral of the creditors, and which consequently increased the liability and reduced assets of the bankruptcy. This may, for example, include paying the current account to the director / shareholder, granting an excessive remuneration to his management company, etc.
- Gross negligence that contributed to the bankruptcy
In the event of a bankruptcy where the debts exceed the benefits, the directors can be held liable for (part of) the company’s debts up to the amount of the shortfall. This will be the case when an obvious gross negligence has contributed to the bankruptcy. Such infringement must then be so important or even essential to the maintenance and existence of the company. Moreover, it must be a mistake which a prudent and reasonable director would not make. The concrete circumstances of the error must thus be taken into account in the assessment. The current constellation can be a mitigating factor. Selling assets at a reasonable price to save the company will not be considered such a mistake. On the other hand, the transfer of clientele and material fixed assets at book value to an affiliated company will be considered gross negligence.
- Special liability for VAT and social security debts
A special liability applies to directors for unpaid withholding taxes and VAT. This liability does not apply automatically. The tax authorities must indeed be able to demonstrate the director made a mistake. For example, not forwarded taxes to the authorities to obtain unlawful credit and thus create an appearance of solvency to the outside world, will be such a mistake. If the tax debts repeatedly remain unpaid, a presumption of liability even arises, so that the directors will then have to proof that they are innocent. Recurrence occurs when the tax debts have not been paid at least twice within a period of one year. The Supreme Court recently ruled that the directors can already be held liable while the bankruptcy procedure is still ongoing and even if there is a prospect of payment from the bankrupt estate.
A similar ground of liability has been introduced for unpaid social security contributions.
- Criminal sanctions
The Belgian Criminal Code provides for a number of criminal sanctions that relate to the insolvency of a company. For example, the directors can be punished if they entered into commitments that were too excessive for the company while there was no reasonable consideration. A prison sentence of one month to one year can then be imposed and a fine of one hundred to one hundred thousand euros. Prison sentences and fines are also imposed for directors who, with the intention of delaying bankruptcy, pay a particular creditor to the detriment of the bankrupt estate. Or for directors who have failed to file for bankruptcy within the statutory periods. The criminal code also provides for fines and prison terms in various other situations.
To avoid liability, it is important that the directors proceed with caution in a period of crisis as it currently taking place. It is also essential that all decisions are adequately documented through the minutes of boards of directors, special reports, etc. In times of pressure, this is often forgotten, so that one must start his defense without weapons. It is therefore essential to properly document and substantiate the decisions taken.
The EY Law team has extensive experience in assisting companies in difficulty and in advising on directors’ liability. If you have any concerns about this or wish to know your rights if you have suffered damage, we can always provide the necessary support.
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